If Kaylie Windham has $425,000 to put into an account today, what series of cash

Question

If Kaylie Windham has $425,000 to put into an account today, what series of cash flows can be withdrawn starting at t-0 (today) if all cash flows are to have equal purchasing power (assume inflation equals 2 percent per year) and you would like them to continue forever? Assume the account earns 7 percent per year. a. Cash flows that begin with $29,750 at t-0 and increase each year by 2 percent into infinity. b. Cash flows that begin with $21,250 at t-0 and increase each year by 2 percent into infinity. c. Cash flows that begin with $20,782.21 at t-0 and increase each year by 2 percent into infinity d. Cash flows that begin with $20,998.43 at t-0 and increase each year by 2 percent into infinity. e. Cash flows that begin with $19,859.81 at t-0 and increase each year by 2 percent into infinity.

Explanation / Answer

PV = $425000

Ke = 7%

Inflation rate is 2% that is g

Therefore annula cash inflow is

PV = annual inflow/(ke-g)

Annual inflow = 425000*(7%-2%) = 21250

Therefore answer is (b)

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